A worker receives a wage rate w and has L hours of leisure every day (the total endowment of hours is 24
hours per day). The government gives a subsidy of rate S of his income. The worker spends all his income.
1. Write a budget constraint of this individual and plot it.
2. Display graphically what is the optimal consumption-leisure choice for this worker.
3. Imagine that instead, the government imposes income tax at rate T . What is the new budget
constraint? Display on the same picture. In the new optimum is the consumption higher? Explain the
answer in terms of wealth and substitution effects.